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Bequest Allocation and Bequest Location

In financial planning we talk a lot about asset allocation — what portion of your portfolio is allocated to US stocks, international stocks, bonds, etc. And we talk about asset location as well, which is the idea that you can achieve tax savings by making sure your least tax-efficient assets are in retirement accounts rather than in taxable accounts where they’ll generate considerable tax costs each year. (For example, if you own a high-yield bond fund or actively managed stock funds with high turnover, it’s best not to own them in taxable accounts.)

I would like to propose the terms bequest allocation and bequest location as well.

Your bequest allocation is what portion of your assets will go to which parties, upon your death (or upon the second death of you and your spouse).

And the bequest location concept is analogous to asset location. That is, after deciding your bequest allocation, it’s wise to take some time to think about which assets should be used to satisfy which parts of your bequest allocation.

For example, imagine that you are a grandparent and you have decided that you want your bequest allocation to be 40% to your children, 10% to your grandchildren, 50% to charity.

And imagine that your assets are roughly broken down as: 40% tax-deferred accounts, 25% taxable accounts, 15% Roth IRA, 20% real estate (your home).

How should you divvy up those accounts to meet the desired bequest allocation? Many people might default to simply taking a pro-rata approach, but there’s a much better solution.

First things first: tax-deferred accounts are the ideal asset for giving to charity, because the charity doesn’t have to pay any tax on the money, whereas any individual would have to pay tax as distributions are taken from the account.

And for the opposite reason, the Roth accounts should go to a human rather than to charity. That is, a charity has no reason to prefer Roth dollars over tax-deferred dollars, whereas your kids (or grandkids) definitely would prefer Roth dollars.

So should the Roth IRA go to your kids or grandkids? Back when Roth IRAs could be stretched over a beneficiary’s lifetime, it often made sense to leave them to the youngest people, to get tax-free growth for as long as possible. Today though, they often have to be distributed over 10 years regardless of whether they’re going to kids or grandkids. So now it often makes sense to leave the Roth dollars to the generation that has the highest marginal tax rate. (Note though that if the grandkids are under 18 or under 24 and full-time students, the kiddie tax could cause your grandkids to have a marginal tax rate that’s the same as their parents’ rate anyway.)

Taxable assets work well for either party. Again, any assets are tax-free to a tax-exempt charity. And any humans who inherit taxable assets will receive a step-up in cost basis, thereby allowing them to sell the assets immediately (if desired) and incur little to no tax.

So in the above example, the ideal bequest location would probably be:

  • The tax-deferred assets (40% of the total assets) go to charity,
  • A portion of the taxable assets (10% of the total assets) goes to charity,
  • Another portion of the taxable assets (10% of the total assets) goes to your grandkids,
  • The rest of the taxable assets (including the home) as well as the Roth IRA go to your kids (40% of the total assets).

In short, the idea is: prioritize Roth for humans, prioritize tax-deferred for charity. And to the extent possible, especially prioritize Roth assets for humans with the highest tax rates.

What Comes After Financial Independence?

Among people who read personal finance books, many save a high percentage of their income through most of their careers. One thing that eventually happens for some such people is that they reach a point at which they realize they have not only saved "enough," they have saved "more than enough." Their desired standard of living in retirement is well secured, and it’s likely that a major part of the portfolio is eventually going to be left to loved ones and/or charity. And that realization raises a whole list of new questions and concerns.

This book’s goal is to help you answer those questions.

More than Enough: A Brief Guide to the Questions That Arise After Realizing You Have More Than You Need

Topics Covered in the Book:
  • Impactful charitable giving
  • Talking with your kids or other heirs
  • Qualified charitable distributions
  • Deduction bunching
  • Donor-advised funds
  • Trusts
  • Click here to see the full list.
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